First, three Gulf Coast refineries shut down last fall are only now beginning to return to operation.

Compared to weekly data last year for the similar period (the four weeks ending April 15, 2005), gasoline production for the most recent four-week period is down 457,000 barrels per day, while gasoline demand is up slightly compared to last year. As a result, finished gasoline inventories have been pulled down sharply, dropping more than 20 million barrels over the past four weeks, despite large volumes of imports. However, as these refineries return to full operation, gasoline production should increase, thus adding much-needed supply into the system.

Second, crude oil prices have climbed to more than $70 a barrel, which is "higher than EIA had expected."

Third, notes EIA, is the shift from MTBE to ethanol, which in some areas of the United States has caused problems, "most notably much of the East Coast and major cities in Texas."

In summary, says EIA, "significant increases in gasoline production as refineries undergoing maintenance return to full operation sometime over the next several weeks should stem the rise in gasoline prices and may, actually, cause them to decline somewhat." While demand will generally increase as we move closer to summer, increased domestic production, in addition to the expected continuation of significant volumes of gasoline imports, should be enough to cause prices to begin to fall again, albeit not nearly as much as they have increased. Whether this occurs later this month or next, EIA does expect prices to begin to come down. While the average U.S. price of regular gasoline could reach $3 per gallon sometime this year, that outcome is by no means a foregone conclusion given the current market situation.

Gasoline Price Volatility in 2004: What's Going On?
An Overview

In January 2004, at a time when retail prices typically reach their lowest level of the year, retail gasoline prices instead increased to their highest level since October 2003. In fact, gasoline prices reached their highest level ever recorded in January. At the same time, U.S. crude oil inventories hit their lowest level since 1975.

Based upon history, this is likely only the beginning of the price volatility that consumers could see at the pump over the coming months. Convenience store retailers, which sell more than 70 percent of the gasoline purchased in the U.S., are closely watching several factors that could trigger shortages and result in "upstream" price increases before the gasoline even reaches their stores. For example, in addition to low crude supplies, the annual transition from winter-blend to summer-blend fuels historically has had a significant impact on supplies and prices.

Because there are so many variables that impact the price of gasoline, it is difficult to accurately predict what will happen to retail gasoline prices in 2004. However, if supplies remain low and demand for gasoline remains strong, the U.S. fuels distribution system could be vulnerable to supply and demand imbalances. And, continued speculation on the oil market could lead to higher prices brought on by world and national events, as well as seasonal cycles. Moreover, because prices today are higher than they have been at this time in previous years, the impact of seasonal variations could be more pronounced than in years past.

Seasonal transition to affect supply... and prices
Because demand for gasoline typically is lowest in January and February, many refineries schedule routine maintenance activities during this time, requiring operations to be temporarily shut down. This reduces overall production, and while maintenance is timed to coincide with a drop in demand, also coincides with the beginning of the transition season from winter-blend to more environmentally stringent, government required summer-blend fuels, which are more difficult and expensive to produce. These fuels must be sold at wholesale by May 1, meaning that refineries must convert their operations to produce these new blends as early as February. This period has historically marked the beginning of a steady draw-down of winter-grade fuel supplies that results in an increase in retail prices, continuing until the transition is complete, usually in mid-June. For more information on the seasonal transitions, please see "Price Volatility Since 2000: Seasonal Transitions and Major Events."

Crude oil prices are high, supplies historically tight... boosting retail gasoline prices
Current retail gasoline prices heading into the transition season are higher than in the previous three years largely because of the high price of crude oil. In January 2004, crude oil prices regularly reached $35/barrel. This was far above the four-year average price for crude oil of $28.41, as well as the $28-$30 per barrel range predicted by most experts. Typically, a $1 increase in the price of a barrel of crude oil results in a roughly 2.5-cent increase at the pump. Consequently, the current price of crude oil prices helped raise the cost of a gallon of gasoline by more than a dime per gallon above expectations. U.S. crude oil inventories, which as of January 2 were already at their lowest level since 1975, dropped another 5 million barrels the following week. At 264 million barrels, they were 6 million barrels below the Lower Operational Inventory (LOI) level defined in 1998 as that necessary for refining efficiency. In addition, gasoline inventories stood 31 million barrels (or 10 percent) below their four-year average. These low inventories have helped spur price speculation in the crude oil markets that kept prices higher than usual and placed significant pressure on the retail gasoline market. For additional information about the impact of crude oil on retail gasoline prices, please see "Crude Oil's Impact on the Gasoline Market."

Other factors could affect prices this spring
There are five additional contributing factors that could continue to influence markets in the weeks and months to come:

Cold weather: If the recent cold snap across much of the U.S. continues some experts have said it could be the worst winter in 25 years -- demand could force refiners to continue refining a greater amount of distillate home heating oil than they would otherwise. This would reduce refiners' capacity to produce gasoline, exacerbating the traditional seasonal draw-down and delaying the production of summer-time gasoline, each of which would contribute to lower supplies, which has historically led to higher prices.

Crude oil supply and imports: U.S. commercial crude oil inventories are at their lowest level since 1975, limiting U.S. refineries' ability to produce more product. As a result, any further increases in demand must be matched by an increase in imports. However, it is unclear whether an increase in imports is close at hand or is still weeks away from arriving.  In addition, the U.S. government will continue purchasing crude oil from the market in order to enhance its domestic energy security by maximizing its available emergency supply in the Strategic Petroleum Reserve, lowering available inventories which could contribute to higher prices in the short term.  Furthermore, as U.S. refineries transition to producing cleaner summer-grade gasoline, which requires more crude oil to produce than does winter-blend fuel, crude oil demand will increase in order to maintain the same level of gasoline production.

OPEC production cuts: In a surprise move, the Organization of Petroleum Exporting Countries (OPEC) on Feb. 10 announced that it will cut its official limits on the output of crude by one million barrels a day beginning April 1. OPEC had also agreed to eliminate about 1.5 million barrels a day of what is called quota busting exceeding agreed-upon limits on production to take advantage of high prices. If OPEC members stick to the agreement, the two measures together would effectively cut OPEC's daily output by about 10 percent. The cut would bring output limits to 23.5 million barrels per day.

MTBE: Three states, collectively representing more than 48 million people or one-sixth of the nation's population have banned the use of MTBE (methyl tertiary-butyl ether), a gasoline additive previously used in gasoline sold in those states. New York, Connecticut and California must now rely upon gasoline containing Mid-West produced ethanol, which must be delivered via rail, truck or barge not pipeline. For New York and Connecticut, the impact could be felt throughout the Northeast as well as in those markets that supply the gasoline to the region. In California, the transition began last year as several refiners voluntarily removed MTBE from their products. While the transition seemed relatively smooth in 2003, the loss of flexibility that accompanies the ban may complicate matters in 2004. Any challenges to supplies in California would be felt throughout the western United States.

Refining efficiency: The domestic refining industry has been operating at or near capacity for several years and events in 2003 demonstrated that any disruption to the system can have a significant effect on supply and prices. Because there are only half as many U.S. refineries in operation today as there were in 1980, combined with much stronger demand over the same time period, the industry is forced to operate under considerable pressure, which contributed to several unanticipated disruptions last year. At one time, as many as six refineries throughout the U.S. had to reduce their production due to operational problems. As 2004 began, the pressures on the industry have only increased and the potential for disruption remains high.